Federal Reserve Terminates the Influencer-Approved Bull Market

For years, the adage “Don’t fight the Fed” meant only one thing: buy stocks. Now, legions of newbie investors who’ve never had to face inflation before are learning it can mean something else, too.

Battered for months by hawkish pronouncements by Jerome Powell, a man investors once considered their staunchest ally, the S&P 500 finished Monday more than 20% below its last record close, ending a two-year bull run that was among the most powerful ever recorded.

That Powell’s Fed should end up being the selloff’s star villain is bitter medicine for people who thought they had the market figured out. A booming economy, strong earnings estimates and still-flush consumers weren’t enough for stocks bulls to overcome red-hot inflation and a Fed chair hellbent on tamping it down.

This has resulted in a severe drop for newly-christened equity fans, once outfitted with government stimulus check and encouraged to wager them long by many online impresarios or other new-wave advice providers. It turns out that investing is still risky, especially when the central bank changes their course.

“The Fed put is a wing and a prayer at this point,” Victoria Greene, chief investment officer at G Squared Private Wealth, said by phone. “Investors should prepare for more pain.”

The S&P 500 fell 3.9% Monday after a ninth weekly decline in 10, becoming the latest benchmark to endure a drop of at least 20%. Small-cap Russell 2000, which is comprised of small-caps, entered a bearish period in January. The tech-rich Nasdaq 100 followed suit two months later.

The decline makes Jan. 3 the end to what was in many aspects an unprecedented bull market for the S&P 500. The current one was only 651 days old when it began on March 23, 2020. It made up the difference in speed and duration. These were its greatest ever annualized gains of 53% over that stretch.

Continue reading: How Tech Stocks are Falling

The bounty of the pandemic bottom is still plentiful. Anyone lucky enough to have purchased stocks at the pandemic bottom is still — even after Monday’s beatdown — sitting on a gain that annualizes to almost 30%, while over the past three and five years the return is above 11%.

You can get a sense of an era’s flavor from the people it made famous. The role of securities industry gurus Henry Blodget, Jack Grubman, and others in the creation of an official veneer for what became a harsh reckoning for speculators was ridiculed by regulators. In the latest trip up, it wasn’t Wall Street analysts but do-it-yourself tastemakers on social media who did most of the cheering.

The Fed is responsible for much of the rally. It rushed to help in March 2020 following the devastating pandemic that caused shutdowns and slowed the economy. Soon after, government stimulus was paid directly to households. This flooded the market with cash in an uncommon joint easing.

Armed with free dollars and stuck at home with no sports to bet on, many Americans turned to the stock market, urged on by social-media stars like Barstool Sports’ Dave Portnoy, who insisted that stocks never go down.

Retail mania culminated in January 2021, when a dizzying rally in GameStop Corp. captured the country’s attention, making a star of Keith Gill, the trader known as “Roaring Kitty.” Day traders went on to frantically bid up a wide range of fringe, oddball stocks in what became one of the greatest euphoric episodes in recent history.

“The ones who came in at the height of this as money was easy, as liquidity was abundant — it’s got to be brutal for them,” Quincy Krosby, chief equity strategist at LPL Financial, said by phone. “The market is very much like mother nature. When you believe you know mother nature, you suddenly get slammed by major snowstorms. This is the market at work.”

The same stimulus, the last round of which passed in spring 2021, and Fed largesse bear some of the blame for the surge in inflation that’s now forced the central bank to go full bore in its battle to tame it. A new role of the central bank as market antagonist is not familiar to investors, who are used to short pullbacks.

With interest rates rising, equity valuations have lost some of their dotcom-level logic. With the S&P 500’s price-earnings ratio dropping from 25 in January to 19 Monday, the multiple contraction has accounted for the entire plunge in equity prices.

Companies like Bed Bath & Beyond Inc. and AMC Entertainment Holdings Inc. that had little or no earnings had no trouble surging in the meme era of easy money. These companies are now in trouble. From 2021’s peaks, there have been losses of more than 60% in many markets, including unprofitable tech firms and newly-public stocks.

Cathie Wood’s ARK Innovation ETF, is one notable victim. The fund, which surged 149% in 2020 alone, is down more than 75% from last year’s high, close to wiping out its whole gain during the pandemic bull market.

“If the Fed is guilty of causing this bear market, it was by overstimulating the bull market in 2021,” said Michael Shaoul, chief executive officer of Marketfield Asset Management. “The most important thing is that you don’t have a portfolio designed to do well in the kind of environment that existed between 2011 and 2021, because that environment no longer exists.”

The day-trader army has been slow to heed the Fed’s shift. Since the beginning of this year, they have been purchasing dips after dip as their losses mount. Market watchers believe that the bottom won’t form until these market participants capitulate.

The term bear market, while it may seem like something that Wall Street has created randomly, is actually a link between Wall Street and the real world. Fourteen times the S&P 500 has completed the requisite 20% plunge in the last 95 years. Only three times did the American economy shrink in a single year during those instances. Among 14 recessions over the span, only three weren’t accompanied by a bear market.

Is this the end of the selloff? The past may be a guide for the future. More pain could lie ahead. Since 1927, the median bear market had tended to last 1.5 years, with the S&P 500 falling 34% over the span. Only three of the 14 previous cycles ended in less time than four months.

Matching that median drawdown would put a floor at 3,179, or about 15% below the index’s recent levels.

“The Fed’s easy money along with the government handing out millions of stimulus checks created a massive bubble in stock prices during the pandemic. Now we’re paying the price,” said Adam Sarhan, chief executive officer of investment advisory service 50 Park Investments. “The wallstreetbets crowd may have perpetuated the problem, but they were more of a symptom of a greater issue driven by the Fed and extreme fiscal policy.”

—With assistance from Isabelle Lee.

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